Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

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Techniques for Managing Earnings


Howdofirmsmanageearnings?Oneaspectofgoodearnings
managementisthecareandnurturingofanalystexpectations,
a practice that Microsoft perfected during the 1990s.
Executivesatthefirmmonitoredanalystestimatesofearnings
andsteppedintolowerexpectationswhentheybelievedthat
the estimates were too high.
8 Thereareseveralothertechniquesthatareused,andwewill
considersomeofthemostcommononesinthissubsection.
Notallthetechniquesareharmfultothefirm,andsomemay
indeed be considered prudent management.



  • Planningahead.Firmscanplaninvestmentsandasset
    sales to keep earnings rising smoothly.

  • Revenuerecognition.Firmshavesomeleewayasto
    when revenues have to be recognized. As an
    example,Microsoft, in1995, adoptedan extremely
    conservative approach to accounting for revenues
    fromitssaleofWindows 95 andchosenottoshow
    large chunks of revenues that they were entitled
    (though not obligated) to show.
    9 In fact,thefirmhadaccumulated$1.1 billionin
    uncountedrevenuesbytheendof 1996 thatitcould
    borrow on to supplement earnings in weaker quarters.

  • Book revenues early. In an opposite phenomenon,
    firmssometimesshipproductsduringthefinaldays
    of a weak quarter to distributorsand retailersand
    record the revenues. Consider the case of
    MicroStrategy,atechnologyfirmthatwentpublicin
    1998. In the last two quarters of 1999, the firm
    reportedrevenuegrowthof 20 percentand 27 percent
    respectively,butmuchofthatgrowthwasattributable

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